Green technology, aviation, biotech — you name it. Policymakers across the country are trying to lure the latest in-vogue industry to set up manufacturing clusters within their respective jurisdictions. However, government support for manufacturing clusters may not be as effective as other policies, such as free trade or building bigger cities, in boosting the incomes of the people they represent.

Clusters are the geographic concentration of interrelated industries, specialized services, and customers. Michael Porter, one of the leading proponents of clusters, has argued they have numerous potential benefits, such as increasing the productivity of participating companies, augmenting their rate of innovation and stimulating the formation of new firms.

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That’s the theory. Yet, two C.D. Howe Institute studies published this year show cluster proponents may not have the evidence on their side when they argue clustering firms within the same industry is a major driver of income growth.

While most cluster studies have focused on specific regions, they have broader national implications. When some industries cluster in a region, this might come at the expense of other regions or other industries (gains from clustering in some locations might well be dampened by losses in other locations). Touting the (empirically small) benefits of clusters at the local level might well overstate their national effects.

When considering the evidence in this way, it becomes clear that between 2001 and 2009 there has been only a weak link between changes in the geographical concentration of manufacturing industries and their economic performance in Canada. Silicon Valley and Kitchener-Waterloo — the not-so-secret dream of every local policymaker — are exceptions, not the rule.

Overall, Canadian manufacturing industries are less geographically concentrated than their counterparts in the U.S., the UK, France, and Japan. Furthermore, there has been a trend of manufacturing sectors becoming less spatially concentrated during the first decade of 2000.

A doubling in the geographic concentration of firms in an average manufacturing sector would, on average, boost blue-collar wages by about 1%. The effect on white-collar wages in high-tech industries is slightly larger and stands at about 5%.

While these numbers look exciting at first sight, at second glance they reveal small productivity and wage effects. Doubling the geographic concentration of firms in an industry is a herculean task that is likely to be beyond regional or even national economic policy. Such a doubling would amount to the reshuffling of large portions of an industry across locations. This could only be achieved at very high cost, if at all. Unfortunately, those costs are likely to exceed many times the expected productivity gains from clustering.

Cluster policies — be they local or national — do not provide cost-efficient solutions to the productivity problem. What else can be done?

Instead of trying to build up single industries, a better approach for local policymakers would be to increase the accessible number of people and firms of all industries in an urban area.

Past studies that have touted the benefits of clusters on economic growth may have conflated the benefits of clusters of specific industries with the benefits of urban areas as a whole.

There are numerous potential economic benefits of accessing a wider urban area. People benefit from being around others who work in different industries when ideas can cross-fertilize between sectors. People learn faster when in close proximity to others. Workers in areas that have many types of firms don’t tie their fates to a single industry or firm.

Research shows that incomes tend to increase where population density is higher. For example, doubling the size of the accessible labour market in Canadian urban areas could increase incomes by about 4%.

Occasionally, business and industry sectors cluster together naturally, because they see and seek the benefits of doing so. But when firms take actions that only benefit themselves, there is little reason for governments to nudge them into making those decisions.

Governments are better suited to accentuating the reasons behind why firms and people of different stripes co-locate in urban areas. For example, when people move to large cities, they benefit those who already live there, even if that isn’t necessarily their intention. In such instances — [D2]when people make decisions that do not account for their effects on other –, there is a case for governments to step in to correct those decisions.

Policymakers can achieve these kinds of gains by reducing congestion in urban areas; a much more attainable goal than enticing firms to relocate. They can also re-examine policies that keep people from pursuing better opportunities in prosperous urban regions.

Employment Insurance (EI), which is more generous and easier to access in rural Atlantic Canada, is a prime example. The regional dimension of EI limits the employment opportunities for people who do not move. But people in urban areas also miss the benefit of greater urban agglomeration.

Another obvious alternative to cluster polices is to expand international trade. There was a much stronger positive relationship between trade and productivity between 2001 and 2009 than between clustering and productivity.

More exports and imports boost both value added per worker and average wages. A doubling of Canadian exports in an average industry increases, on average, blue-collar wages by 6%, an effect that is six times larger than that of a doubling of clustering.

The policy message is that international trade has a stronger positive impact on productivity than the clustering of Canadian manufacturing industries. The issue with trade policy is, of course, the absence of control as to where the positive effects materialize, which is precisely what makes cluster policies so attractive to local policymakers. The same holds true for policies of urban growth, which would obviously only benefit the already large cities.

If national economic performance is the key consideration, there is no reason to opt for cluster policies over, say, trade policy or reducing congestion.

Kristian Behrens is professor of economics at the University of Quebec at Montreal and author of the C.D. Howe Institute study “Strength in Numbers? The Weak Effect of Manufacturing Clusters on Canadian Productivity.” Benjamin Dachis is a Senior Policy Analyst at the C.D. Howe Institute and author of the C.D. Howe Institute study “Cars, Costs, and Congestion: A New Approach to Evaluating Government Infrastructure Investment.”

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